MANAGERIAL ECONOMICS

DR. DIDIN SAEPUDIN, SE, M.SI

SUMBER REFERENSI UTAMA :

DOMINICK SALVAORE
MANAGERIAL ECONOMICS
1-1 THE SCOPE OF MANAGERIAL ECONOMICS

Definition of Managerial Economics

Managerial economis refers to the application of economic theory
and the tools of decision science to examine how organization can
achieve its aim or objectives most efficiently.
o Relationship to Economic Theory
o Relationship to the Decision Sciences
o Relationship to the Functional Areas of Business Adniration
Studies
 Management
Decision Problem

Economic theory : Decision Science :

Microeconomics, Mathematical Economics,
microeconomics econometrics

Managerial Economics :
Application of economic theory
and decision science tools to
solve managerial decision
problem.

OPTIMAL SOLUTION
TO
MANAGERIAL DECISION
PROBLEM
The Nature of Managerial Economics
1-2 THE THEORY OF THE FIRM

Reason for the Existence of Firms and Their

Function.
Firm Exist because it would be very ineficient and costly for
entrepreuneurs to enter into and enforce contracts with workers
and owner of capital, land, and other resources for each separate
step of the production and distribution process.
The function of firms, therefore, is to purchase resources or
inputs of labor services, capital, and raw material in order to
transform them into goods and services fo sale.
The objective and Value of the Firm
The primary goal or objective of the firm is to maximize the wealth or value of
the firm.
Formaly stated, the wealth or value of the firm is given by
Present Value (PV) of Profit.

Constrains on the Operation of the Firm

Firm faces many constrains :
Skilled labors/workers
Factory and warehouse space
Capital
Legal
Limitation of the Theory of the Firm
The theory of the firm which that the goal or objective of the
firm is to maximize wealth or the value of the firm has been
criticized as being much too narrow and unrealistic. In its
place, broader theories of the firm have been proposed. The
most prominent among these are models that postulate that the
primary objective of the firm is the maximization of sales
(William Boumol), the maximization of management utility
(Oliver Williamson-Pricipal-agent problem), and satisficing
behavior (Hertbert Simon).
1-3 NATURE AND FUNCTION OF PROFITS
 Business versus Economic Profit
Business profit refers to the revenue of the firm minus
the explicit or accounting cost of the firm.
Explicit cost are actual out-of-pocket expenditures of
the firm to purchase or hire the inputs it requires in
production.
Economic profit equal the revenue of the firm minus
explicit cost and implicit cost.
Implicit costs refer to the value of the inputs owned and
used by the firm in its own production process.
Theories of Profit
1. Risk-Bearing
According to this theory, above-normal profit (i.e., economic profit) are
required by firms to enter and remain in such fields as petroleum exploration
with above-average risks.
2. Frictional Theory of Profit
This theory stresses that the profits arises as a result of friction or disturbances
from long-run equlibrium.
3. Monopoly Theory of Profit.
Some firms with monopoly power can restrict output and charge higher prices
than under perfect competition, thereby earning a profit.
4. Innovation Theory of Profit
The innovation theory of profit postulates that (economic) profit is the reward
for the introduction of a successful innovation.
5. Managerial Efficency Theory of Profit
This theory rests on the observation that if the average firm tends to earn only
a normal return on its investment in the long run, firm that are more effiscient
than the avarage would earn above-normal returns and (economic) profits
Function of Profit
Profit serves a very crucial in a free-enterprise
economy, such as aour own. High profits are
signal that consumers want more of the output
of the industry.
High profits provide the incentive for firm to
expand output and for firms to enter the
industry in the long run.
For a firm of above-average efficiency, profits
represent the reward for greater efficiency.
OPTIMIZATION TECHNIQUES

2.1 Methods of Expressing Economic Relationship

Economic relationships can be expressed in the
form of equation, tables, or graph. When the
relationship is simple, a table and/or graph may
be sufficient. When relationship is complex,
however, expressing the relationship in equational
form may be necessary.

For Example : TR = 100Q-10Q2

2-2 Total, Average, and Marginal Relationship
Q TC AC MC

0 $ 20

1 140

2 160

3 180

4 240

5 480
2-3 Optimization Analysis
Optimization analysis can best be
explained by examining the process by
which a firm determines the output level at
which it maximizes total profits.
1. Profit maximization by TR dan TC
Approach.
2. Optimization by Marginal Analysis
BREAK EVEN ANALYSIS
Break even analysis is in some respects a
simplification of profit maximization analysis.
In typical brake even problem, a constant
price, a constant average variabel cost, and a
specific level of fixed cost are assumed; and
the resulting level of output (or dales)
necessary for the firm to cover its cost (to
break even) pr to cover its total costs and
achieve a target level of income is the
obtained.
 BEP FORMULA

TFC
Q-bep = ----------------------
(P – AVC)

TFC = Total Fixed Cost

Q-bep = Quantity BEP
P = Price
AVC = Average Variable Cost
 EXAMPLE

Assume the MAGIC S is fast food retaurant that

specializes in sandwich. Magic S has fixed cost
per month of $20,000. Most of revenue this firm
is derived from featured meal-a hot submarine
sandwich, and small drink, for $1.50. The
average variable cost of meal is approximately
constan at $0.70 over the relevant range
production.
 CASE
Suppose an electric motor manufaturing company has current plant
capacity of 1,000,000 motors per year. Unit variable associated with
this plant are $10, and fixed cost are $ 1,000,000. The current capacity
number of motors can be sold for $20 each. The firm is considering
expanding and modernizing its plant facilities so that the current
capacity will be doubled. Under this proposal, unit variable costs
would be expected to decrease to $5, and fixed costs would be
expected to increase $2,000,000. The firm estimates that it could sell
1.5 million motors at a price of $15.
a. Find the break-even quantity and break-even dollar sales of present
plant and proposed plant.
b. Do you recommed that the firm expanding and modernizing its plant
facilities.
MARKET DEMAND ANALYSIS FOR DECISION MAKING

Demand Function and Demand Curve

Demand function refers to the relationship that exist

between the quantity demanded of particular product and all
determinant of demand.

Demand curve refers to the relationship that exist between

quantity demanded of particular product and the price of that
product, with all other influencing factors held constant.
THE DETERMINANT OF DEMAND FOR A PRODUCT
Qx = f{Px, Ax, Dx, Ox, Ic, Tc, Ec, Py, Ay, Dy, Oy G, N, W}
Strategic Consumer Competitor Other
Variables Variables Variables Variables

Where
Qx is the quantity demanded of product X, per period
Px is the price of product X
Ax is advertising/promotion for product X
Dx is design/style/quality of product X
Ox is outlets for distribution
Ic is incomes of consumers/customers/clientele
Tc is tastes and preference patterns of consumers
Ec is expectations of consumers regarding future prices, etc.
Py is prices of related (subtitutes, complements)
Ay is advertising/promotion for related goods
Dy is design/quality of related goods
Oy is competitor distribution outlets
G is government policy
N is number of people in the economy
W is weather conditions
THE FORM OF THE DEMAND FUNCTION
Qx=α + β1Px + β2Py + β3Ax + β4Ay + β5Ic + β6Tc + β7Ec + β8N

Example : suppose the demand for product X has been estimated (using regression
analysis) to be

Qx = 5,030 – 3,806.2Px + 1,458.5Py + 256.6 Ax – 32.3Ay + 0.18Ic

Suppose :
Px = $ 8
Py = $ 6
Ax = $ 168 (in thousands)
Ay = $ 182 (in thousands)
Ic = $ 12, 875
We find : Qx = 22,879.1
THE DEMAND CURVE DERIVED FROM THE DEMAND FUNCTION

Qx = A + β1Px
Where :
A = α + β2Py + β3Ax + β4Ay + β5Ic + β6Tc + β7Ec + β8N
Qx = 53,329.7 – 3,806.2 Px

Movement Along versus Shifs of the Demand Curve

(grafik)
RELATIONSHIP AMONG PRICE, TOTAL REVENUE, AND MARGINAL REVENUE

Example : Suppose the demand curve for a carton

of twelve cans of dog food at a dicount super-
market during a particular month specifieced by :

Px = 11 – 0,001 Qx

Marginal Revenue is defined as the change in

total revenue that results from a one-unit increase
in quntity demand.
 Price Quantity Total Revenue Marginal Revenue
($/unit) Demanded (Unit) ($) ($/unit)
10
9
8
7
6
5
4
3
2
1
The Concept of Elasticity
Elasticity is the commonly used measurement of the sensitivity
of the change the demand function to changes in any of its
variables.
Measurement of Elasticity
In General, the elasticity of any function is defined as the
percentage change in the dependent variable that is cuased
by one percent change in one independent variable while all
other variable are held constant.
Percentage change in the dependent variable
Elasticity =
-------------------------------------------------------------------------------
Percentage change in the independent variable
PRICE ELASTICITY OF DEMAND

The relationships between price, marginal revenue,

and total revenue can be summarized in a single
number as the price elasticity of demand.
Definition : Price elasticity of demand is defined as
the percentage change in quantity demanded
divided vy a small percentage change in price.
Ilustration : Example demand curve Px= 5-
0.625Qx
PRICE ELASTICITY, MARGINAL REVENUE, AND TOTAL REVENUE
Relationship between price elasticity and total revenue
Elasticity Value Price Increases Price Decreases
∞ > |ε | > 1 TR falls TR rises
∞ > |ε | = 1 TR constant TR constant
0 < |ε | < 1 TR rises TR falls

Point versus Arc Elasticity

Point Elasticity : ε = ∂Qx / ∂Px ● Px/ Qx

Arc Elasticity : ε = ∆Qx / ∆ Px ● (P1 + P2)/ (Q1 + Q2)

Example : Demand curve of product X is Px = 5- 0,625Qx and when Px = $ 8.00,
Qx = 22,879. So What is the price elasticity at this point on the demand curve ?

Example : Suppose a small store has been selling hangging flowerpots over the last
few months at a price of $ 8 per unit and sales have stabilized at about 32 unit per
week. The store manager now reduces the price of those flowerpots to $ 7 per unit
after a couple of weeks find that sales have stabilized at new level of 44 per week.
Elastic versus Inelastic
1. If I e I = 1, the function is unit elastic, meaning that a 1 percent
change in the independent variable will cause a 1 percent change
in dependent variable

2. If I e I > 1, the function is elastic, meaning that a 1 percent

change in the independent variable will cause greater than a 1
percent change in dependent variable

3. If I e I < 1, the function is inelastic, meaning that a 1 percent

change in the independent variable will cause less than a 1
percent change in dependent variable
INCOME ELASTICITY OF DEMAND

Definition : The income elasticity of demand may

be defined as the percentage change in quantity
demanded divided by percentage change in
consumer income, ceteris paribus, that is,
θ = % ∆Qx / %∆ Ic
Example : Estimated demand function as
Qx = 5,030 – 3,806.2Px + 1,458.5Py + 256.6 Ax – 32.3Ay + 0.18Ic
Ic = $ 12, 875
We find : Qx = 22,879.1
Point income elasticity ?
Luxuries, Necessities, and Inferior Goods
Definition : Luxuries are products for which the proportionate
change in quantity demanded is greater than the proportiionate
change in consumer income levels; income elasticity for
luxuries is, therefore, positive and greater than unity
( grafik ilustration)
Definition : Necessities are product which have an income
elasticity of demand wkhich is positive but less than one.
Definition : Inferior goods are products which exhibit a negative
income effect and, consequently, have negative income
elasticity.
BUSINESS IMPLICATIONS OF INCOME EALSTICITY
Income Elasticity and Luxuries, Necessities, and Inferior Goods
Income Elasticity Product Class Increased Income Decreased Income
Qx increases by Qx decreases by
∞>θ >1 Luxuries greater percentage greater greater
percentage
Qx increases by Qx decreases by
1>θ>0 Necessities
lesser percentage lesser percentage
0 > θ > -∞ Inferior Goods Qx decreases Qx increases

The implication of income elasticity of demand to the business decision maker are
considerable. If the income elasticity for your product exceeds unity, the demand for
your product will grow more rapidly than does total consumer income, and it will
fall more rapidly than does total consumer income whwn income levels are generally
falling.
CROSS ELASTICITY AND OTHER ELASTICTIES
Definition : Cross elasticity of demand is defined as the
percentage change in quantity demanded of product X, divided
by percentage change in the price of some product Y. That is,

η = % ∆Qx / %∆ Py
Substitutes and Complements
Definition : Substitute are pairs of products between which the cross elasticity of
demand is positive.
Definition : Complements are pairs of products between which the cross elasticity
is negatif.
(illustration)
 CASE
The demand function for Fritz Reinhart premium beer has been estimated as

Qx = 37,986.5 – 4,476,9Px + 2,994.2Py + 668.2Ax – 849.7Ay

where Qx is the demand for Reinhart beer (in sixpacks); Px is the price of Reinhart beer (in
dollars); Py is the price of the main rival beer (in dollars); Ax is the advertising expenditure
for Reinhart beer ($000); Ay is the expenditure for the rival beer ($000). The curret value of
the independent variables are Px = 9.95; Py=8.95; Ax = 36; and Ay = 22.

(a) What is the current level of demand for Reinhart beer

(b) Calculate the price elasticity of demand for Reinhart beer.
(c) Calculate the cross-price elasticity of demand Reinhart beer
(d) If the marginal cost of producing Reinhart beer is contant at $4.00 per
sixpack, should the firm changes its price to maximize profit ? Explain.
(d) Suppose instead that the Reinhart beer company wishes to maximize
sales revenue from this beer. What price should it set ?
 CASE
Billabong Boomerangs, Inc., and Swahili Spears are direct competitors in the fast-
growing segment of the hunters’ equipment market. Because of recent intense
competition, both companies have redeveloped their main product, requiring the
users’ skills to be less developed than before and thus avoiding extensive field trips by
company representatives for on the job training. This also reduced the need for costly
instruction manuals. Stephen Pesner, president of Bilabong Boomerangs, has decided
to hire local market research company to assits his company in planning strategy.
After extensive research using modern methods of data collection and statictical
analysis, the reseachers came up with Billabong’s demand function :

Qb = -1,700 Pb + 750YAh+ 350Ab – 250As + 1,585Ps + 1.05H + 7.25W

where Qb is the quantity demanded of boomerangs: Pb is the price of boomerangs; Yh is the

average income of hunters (in thousands); As is the advertising budget for Swahili Spears (in
thousands); Ps is the price od spears; H is the total number of hunters (in millions); and W is
the estimated population of wildlife (in thousands). The current values of the independent
variables are Pb = 29.95; Yh=12.5; Ab
Demand for Producer’Goods
If goods are created for the ultimate consumer, they are called consumer
goods, even though they pass through a chain distribution in which
considerable buying and selling take places.
If goods are produced because they are needed by another firm to make
additional product, such goods are called producer’s goods.

Demand for producer’s goods is derived from demand for consumer goods.
o Producers’s goods are input factors of production.
o Producer’s goods are homogeneous than sonsumers goods,
factor markets are more competitive and far more sensitive to price.
o The buyers of producer’s goods are profesionals.
o Profesional buyers of producer’s goods are also more demanding
of product quality and supplier integrity.
The Elasticity of Demand
1. Price elasticity of demand, which measure the
responsiveness of sales to change in price.
2. Income elasticity of demand, which measure the
responsiveness of sales to change in consumer income.
3. Cross elasticity of demand, which measure the
responsiveness of sales to change in the price of
another commodity.
4. Advertising elasticity, which measure the
responsiveness of sales to change in the amount spent
on advertising and promotion.
PRODUCTION FUNCTION AND COST CURVE
 The Short-Run Versus Long-Run
In the production and cot theory, the distinction is made between the
short-run, in which the quntities of some inputs are variable while
others are in fixed suplly, and the long run, in which all factors may
be varied.
Labor has traditionally been variable and capital is tipycally fixed in
the short run.
Labor = we think of one unit of labor as including, say
one hour of a worker’s time plus a “package” of all the
necessary raw material, fuel, and other variable input
Capital = we should think of capital as including all the plant,
equipment, land, building, maneger’salary, and
other expenses that do not vary with the level of output.
Production in The Short Run
Definition :
A production function is a technical specification
of the relationship that exists between the inputs
and the outputs in the production process.
Q = f (K. L)
Where : Q is the quantity of putput
K is capital
L is labor
The State of Technology.
State of technology refers to the quality of the resouces involved
in the production process.
Motor Vehicle Assembly Production Function

Labor Unit (L) Assembly Production Function

1 2 3 4 5 6 7 8
Capita 1 1 3 7 10 12 13 13.5 13
l (K)
(000s 2 3 8 14 19 23 26 28 29
of 3 8 18 29 41 52 62 71 79
machi
ne 4 11 23 36 50 65 78 90 101
hours)
5 12 26 42 60 80 98 112 124
The Law of Diminshing Return
Definition :
The law of the diminishing return state that as additional units of the variable
factor are added to the fixed factors in the short run, after some point the
increment to total product will decline progressively.

Units of the Varaible Units of Output (for K = Increment to Output Return to the variable
Factor (L) 3) (Total Product) over Preceding Row factor ( for K=3)
(marginal product)
0 0
1 8
2 18
3 29
4 41
5 52
6 62
7 71
8 79
Total Product and Marginal Product
The total output from production function process is
also known as the total product of the inputs to that
production process.
Marginal Product
Definition :
Marginal product is defined as the rate of change
of the total product as labor is increased, and equal
in mathematical terms to the first derivative of the
total product function with respect to labor.
The Total Product and Marginal Product Curves
SHORT-RUN AND LONG-RUN COST CURVE
The Total Variable Cost Curve
The Total Variable Cost (TVC) curve can be derived from the TP curve simply
by multiplying the level of variable inputs by the cost per units inputs and
plotting these cost data againts the total output level.
Average Variable and Marginal Costs
Definition ;
Average variable cost (AVC) is equal tp TVC divided by output Q at every
level of Q, that is
AVC = TVC/Q
Definition :
Marginal cost (MC) is the change in total costs caused by a one-unit change
in output :
MC = ∆TC/∆Q
Realtionship between the Total Product and Total Variable Cost Curve
Derivation of Average Variable and Marginal Cost Curves from Total Variable Cost Curve
SHORT RUN TOTAL AND PER UNIT COST

Q (output) TFC TVC TC AFC AVC ATC MC

0 60 0
1 20
2 30
3 45
4 80
5 135
 PLANT SIZE AND ECONOMIES SCALE

 Economies scale refers to the situation in which

output grows proportionately faster than input.
 Economies of scale or decreasing cost arise
because :
a. Technological reason
b. Financial reason
 CASE STUDY
 Long Run Average Cost (LAC) of small firm as
percentage of LAC of large Firm.
INDUSTRY PERCENTAGE
Hospitals 129
Higher Education 119
Commercial Banking
Demand deposits 116
Installment loans 102
Electric Power 112
Airline (local service) 100
Railroads 100
Trucking 95
 LEARNING CURVE

 The learning curve shows the decline in the

average input cost of production with rising
cumulative total output over time.
Average cost
Learning curve can be expressed
algebraically as follows :

200 C = aQb

100

100 300 Cummulative total output

MINIMIZING COST INTERNATIONALLY- NEW ECONOMIES OF SCALE

Location and Companies that supply specific parts and component for Dell’ PCs
Part/Component Location Company

Monitors Europe and Asia Philips, Nokia, Samsung, Sony, Acer

PCBs Asia, Scotland, and Eastern SCI, Celstica

Europe
Drives Asia, mainly Singapore Saegate, Maxtor, Western Digital

Printers Europe (Barcelona) Acer

Box builds Asia and Eastern Europe Hon Hai/Foxteq

Chassis Asia and Ireland Hon Hai/Foxteq

IMMIGRATION OF SKILLED LABOR

 CASE
Taras Panache is the owner-manager of Panache Shirts Enterprises,
which manufactures shirts by using space and equipment in a
large warehouse. Because of technical aspects of shirt production
and the aviable equipment, separate production centers are used,
each consisting of one cutting machine, two sewing machines,
and three operators. Six month ago Mr. Panache had only one
such production center, but recently he doubled, then tripled, and
finally quadrupled the number of production centers by renting
more space and equipment and by hiring more operators.
Througout the expansion Mr. Panache hasl personally supervised
all the operator and has handled all aspects of business. He kept a
record of the average daily output from the entire plant for each
of the four situation, as follow :
One production center : 20.6 shirts/day
Two production centers : 42.4 shirts/day
Three production center : 60.8 shirts/day
Four production cnter : 76.3 shirts/day
Each production center cost $ 3,000 per month in fixed and variable cost. Mr.
Panache pays himself $ 3,000 per month, and the remaining fixed cost are
$1,000 per month. Assume there are twenty working days in a month.
(a) Can the expansion of Panache shirts be regarded as a case of an increase in
the scale of operations or simply an increase in the size of operation ?
Why?
(b) Are there economies and/or diseconomies of scale/size evident? Explain.

(c) Indulge in some speculation about the probable cause of the economies and
diseconomies.
MARKET STRUCTURE :

1. Perfect competition
2. Pure Monopoly
3. Monopolistic competition
4. Oligopoly
o The Effect of Sellers’ Characteristics on Market Structure
The nature and degree of competition is influenced by the bumber and
size of the firms operating in the market in relation to the size of the
market.
The Effect of Buyer Characteristics on Market Structure
The nature and degree of competition is also influenced number and size
of the buyers in the market.
The Effect of Product Charactersitic on Market Structure
The most important characteristic of a firm’s product is the degree
to which the product is differentiated from all others in the same market.
Conditions of Entry and Exit
Economic theory holds that profitability within a particular market will
attract the entry of new firms, and lack of profitability (losses) will drive
weaker firm out.
Factor that may barier market entry include the following :
1. Cost of developing a differentiated product plus promotional costs
necessary to penetrate the market.
2. Demand condition, especially price elasticity
3. Control by existing firms over the supply of the factors of production.
4. Control by existing firms over channels of distribution.
5. Legal and institutional factors, such as patents and franchises.
6. Potential economies of scale.
7. Capital requirements.
9. Technological factors.
Economy of Scale
Possible economies of scale in production provide
the best explanation of why there are large firms
in some industries, but not in others.
PERFECT COMPETITION

1. Many small sellers of a homogeneous or

standard product.
2. Many small buyers.
3. Free entry
4. Free mobility of economic resources.
5. Perfect information
6. The firm is a price taker and quantity adjuster.
SHORT-RUN EQUILIBRIUM

Graffic Illustration

Algebratic example :
Suppose we let price P=$10
And assume the cost function
TC = 4 + 4Q + Q2

ILLUSTRATION PERFECT COMPETITION

GRAFFIC

IN GLOBAL MARKET
PURE MONOPOLY
Charateristic of pure monopoly are :
1. One seller.
2. No close substitute
3. No entry alowed
The most common barriers to entry are :
4. Legal or institutional factors, such as patent or franchises
5. Economies of scale that require very large capital outlays.
6. The monopolist’s control of input supplies
7. Demand conditions, such as the market’s inability to absorb
additional production.
8. Technology controlled by the monopolist.
MONOPLIST’S SHORT-RUN OUTPUT AND PRICING DECISION

Graffic Illustration.
To illustrate the monopolist’s output and pricing
decision, suppose a monopolist is faced with
demand and cost function as follows :
Q = 2,000 – 5P
TC = 100 + 4Q + 0.4Q2
MONOPOLISTIC COMPETITION
Chamberlin’s model pictures an industry with four distinguishing
cahracteristic :
1. There are a very large number of small firms offering slihgtly entiated
products in a market in which barriers to entry are very low.
2. The market consists of firms that produce similar product that are close
substitutes for one another. The substutitability of these products provides
the element of competition in monopolistic competition.
3. Because of product differentiation, each firm posses a monopoly over its
own version of the general product. Therefore, each firm may set its own
price, but within limits imposed by competition. Product differentiation
thus provides the element of monopoly in monopolistic competition.
4. Some barriers to entry do exist so that entry is not completely free.
Nevertheless, entry is realtively easy.
STRATEGIC BEHAVIOR AND GAME THEORY

Strategic behaviour refers to the plan of action or

behaviour of an oligopolist, after taking into
consideration all possible reactions of its
competitors, as they compete for profit or other
advantages.
Since there are only a few frims in the industry, the
action of each affects the others, and the reaction of
the others must be kept in mind by the first in
charting its best course of action.
Game theory is concerned with the choice of the best or
optimal strategy in conflict situations.
Every game theory model includes :
1. Players
Decision-maker (here the manager of oligopolist firms)
whose behaviour we are trying to explain and predict.
2. Strategies
Choice to change prices, develop new product, undertake
a new advertising campaign, build new capacity, and all
other such actions that affect the sales and profitability of
the firm and its rivals
3. Payoffs
The outcome or consequence of each strategy.
 PAYOFF MATRIX FOR AN ADVERTISING GAME

FIRM B

DON’T
ADVERTISE
ADVERTISE

ADVERTISE
(4,3) (5,1)
FIRM A
DON’T
ADVERTISE
(2,5) (3,2)

The Dominant strategy is the optimal choice for player no matter what the
opponent does.

Firm A and Firm B have the dominant strategy.

NASH EQUILIBRIUM
Payoff Matrix for the Advertising Game

FIRM B

DON’T
ADVERTISE
ADVERTISE

ADVERTISE
(4,3) (5,1)
FIRM A
DON’T
ADVERTISE
(2,5) (6,2)

Nash Equilibrium is the situation where each player chooses his or her optimal
strategy, given the strategy chosen by the other player.
THE PRISONERS’ DILEMMA
Negative Payoff Matrix (Year of Detention) for Suspect A and Suspect B

INDIVIDUAL B

CONFESS DON’T CONFESS

CONFESS
(5,5) (0,10)
INDIVIDUAL A
DON’T CONFESS (10,0) (1,1)

Prisoner’ Dilemma is the situation where each player chooses his or her dominant
strategy.
PRICES COMPETITION AND THE PRISONERS’ DILEMMA
Payoff Matrix for a Pricing Game

FIRM B

LOW PIRCE HIGH PRICE

LOW PIRCE
(2,2) (5,1)
FIRM A
HIGH PRICE (1,5) (3,3)

You have to determine :

a. Whether Firm A has a domiant strategy ?
b. Whether Firm B has a domiant strategy ?
c. The optimal strategy for each firm ?
 CASE-1
Payoff Matrix for a Pricing Game
FIRM B

HARGA RENDAH HARGA TINGGI

HARGA RENDAH (1,1)

(3,-1)
FIRM A
HARGA TINGGI (-1,3) (4,2)

From the following payoff matrix, where the payoffs are the profits or losses of two forms,
determine :
a. Whether Firm A has a domiant strategy ?
b. Whether Firm B has a domiant strategy ?
c. The optimal strategy for each firm ?
d. The Nash equilibrium, if there is one.
 CASE-2
Payoff Matrix for a Pricing Game
PERUSAHAAN B

HARGA RENDAH HARGA TINGGI

HARGA RENDAH
(2,2) (4,-2)
PERUSAHAAN A
HARGA TINGGI (-2,4) (5,3)

From the following payoff matrix, where the payoffs are the profits or losses of two forms,
determine :
a. Whether Firm A has a domiant strategy ?
b. Whether Firm B has a domiant strategy ?
c. The optimal strategy for each firm ?
d. The Nash equilibrium, if there is one.
RISK AND UNCERTAINTY IN MANAGERIAL DECISION MAKING
Managerial decisions are made under conditions :
1. Certainty
2. Risk
3. Uncertainty

Certainty refers to the situation where there is only one possible outcome to
A decision and this outcome is known precisely.
For example : Investing in Treasury Bill
Risk refers to situation in which where there is more than one possible outcome
to a decision and probability of each specific outcome is known or can be
estimated.
For example : introducing a new product.
Uncertainty is there the case when there is more than one possible outcome
To decision and where the probability of each specific outcome occurring is not
Known or even meaningful.
For example : Drilling for oil in an unproven field carries with uncertainty.
 RISK ANALYSIS
MEASURING RISK
PROJEC STATE OF PROBABILITY OUTCOME EXPECTED
T ECONOMY OF OF VALUE
OCCURRENCE INVESTME
NT
Boom 0.25 $ 600

A Normal 0.50 $ 500

Recession 0.25 $ 400

Expected profit from project A

Boom 0.25 $ 800

Normal 0.50 $ 500

B
Recession 0.25 $ 200

Expected profit from project B

 RISK ANALYSIS

Expected Profit = . Pi

An Absolute Measure of Risk : The Standard Deviation

1. di = Xi – X (bar)

2. Variance = σ2 = . Pi

3. Standard deviation =

Relative Measure of Risk : The Coefficeint of Variation

Coefficeint of Variation = V =